Audit firms disclosure should be made mandatory

Audit firms disclosure should be made mandatory

Professor Roger Willett

Recent articles in the business press have commented on the refusal of the large New Zealand audit firms to share the results of a review of their audit work by the Financial Markets Authority (FMA).

They raise the question of whether there is sufficient transparency to protect the interests of investors and other users of the audited financial statements of large corporates.

The FMA is charged with regulating the financial services industry in New Zealand.

Since 2015, it has produced annual reports reviewing key aspects of the quality of audit work carried out by audit firms. These include the ‘big four,’ namely Deloitte, KPMG, Ernst and Young and PricewaterhouseCoopers.

Trans-Tasman differences

The latest FMA’s Audit Quality Monitoring Report 2017-2018, like its predecessors, finds fault with some aspects of New Zealand audit firms’ work.

The concerns relate to various aspect of the audit including whether there is good quality control of audit work and risk assessment and whether accounting estimates are reasonable.  Underpinning the problems identified, are the fundamental issues of auditors’ independence and the level of scepticism they bring to their work.

A similar review of audit firms’ practices in Australia raised questions about the quality of audit work. The audit firms agreed to disclose the results, which were not entirely uncritical.

This forces us to consider what are the benefits and costs of transparency in these situations. It also begs the question of why the New Zealand arms of audit firms took a different attitude to disclosure of information compared to their Australian counterparts.

Extent of disclosure

One of the difficulties in resolving where to draw the line with disclosing FMA review information, is that transparency related benefits of disclosure are social or ‘public goods.’

However, the potential costs are private, mostly borne by the audit firms.

The FMA would argue that transparency in its audit quality assessments promotes the integrity of, and confidence in, New Zealand’s financial markets, thereby underpinning New Zealand’s economic prosperity.

The audit firms claim, however, that disclosing a league table of their FMA judged performance, breaches the confidentiality conditions of their agreement with the FMA to participate in the review.

Information asymmetry problem

The proponents of greater transparency are in a weak position here.

The FMA are provided access to information relating to the work of New Zealand audit firms.

The audit firms participating in the review have the right to impose an embargo on publication of this information.

There is thus an important ‘information asymmetry’ problem, since those who might have an interest in how well audit work is being done, have no way of finding out such ‘facts.’

Large audit firms are privileged to be able to earn high fees from their clients.

Furthermore, the financial statements they audit potentially have the ability, through the decisions of shareholders and others, to affect the wealth of a large proportion of the New Zealand population.

Some questions

Consequently, we should ask:

Is this type of information asymmetry between powerful, private interests on the one hand and large numbers of less powerful users of audited financial statements on the other, acceptable in a democratic, egalitarian society?

Some might argue that rather than relying on greater voluntary disclosure, it should be mandated by regulation.

The latter would then create a more level playing field to support the integrity of New Zealand’s financial system.

A newspaperman once said that the best way to protect the freedom to publish is to publish.

Perhaps, in this case, the best way to promote transparency is to be transparent?

Dr Roger Willett is Professor at the School of Accounting and Commercial Law, Victoria University, Wellington. The above article appeared in the July 2019 issue of Transparency Times.

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